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Unformatted text preview: UNIVERSITY OF TORONTO Joseph L. Rotman School of Management Feb. 24, 2010 Buti/Farooqi RSM333 MID-TERM EXAMINATION Ganguly DURATION - 2 hours Aid Allowed: Silent electronic calculator and one 1-sided 8 1 2 11 crib sheet Name: Student Number: Circle the section that you are registered in: Buti (Tue. 9a.m.11a.m.) Buti (Tue. 11a.m.1p.m.) Buti (Tue. 7p.m.9p.m.) Farooqi (Mon. 11a.m.1p.m.) Farooqi (Fri. 10a.m.12p.m.) Farooqi (Fri. 12p.m.2p.m.) Ganguly (Mon. 1p.m.3p.m.) Ganguly (Tue. 1p.m.3p.m.) Instructions 1. Write all your answers on the examination paper. 2. Answer five out of six questions. Each question is worth 20 marks. Do not answer all six questions! In the table below, cross out the question that you choose not to answer. Question Marks 1 2 3 4 5 6 Total 1 1. A and B are two firms that are identical in all aspects, except that A is unlevered whereas B has $20 million of perpetual debt at 8% interest rate. Their corporate tax rate is 30% and their expected EBIT are $15 million in perpetuity. The cost of capital for firm A is 15%. (a) Assuming other than the corporate taxes, there are no other market imperfections. What value would each of these firms have? (5 points) (b) For parts (b)(d), we assume that the market value of A and B are V A = $73 million and V B = $77 million respectively. The debt, EBIT of A and B and the corporate tax rate do not change. What expected cash inflow will an investor receive every year if he owns 1% of the shares of A or 1% of the shares of B, respectively? (5 points) (c) What would be the costs of the two different strategies? (4 points) (d) Describe in detail an alternative investment strategy to owning 1% of the shares of A that produces the same risk and expected dollar return but at a lower cost. (6 points) 2. XYZ is an all equity firm with expected earnings before interest and taxes of $4 million in perpetuity and a corporate tax rate of 40%. In the economy, the risk-free rate isin perpetuity and a corporate tax rate of 40%....
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This note was uploaded on 04/23/2011 for the course RSM 333 taught by Professor Sabrinabutti during the Spring '11 term at University of Toronto- Toronto.
- Spring '11